Operating income, also called operating profit or earnings before interest & taxes (EBIT), refers to the amount of sales revenue remaining after subtracting the direct and indirect costs of operations from a company's revenue.
Operating Income FormulasThere are multiple formulas that can be used to calculate operating profit:
- Operating Income = Sales Revenue - Direct Costs - Indirect Costs
- Operating Profit = Gross Profit - Operating Expenses - Depreciation & Amortization (D&A)
- Operating Income = Net Income + Interest Expense + Taxes
- Direct costs are the expenses incurred in the process of producing products or providing services to the customers. These costs can be either variable or fixed costs. Direct costs include direct materials, direct labor, cost of merchandise, power consumption, shipping costs, etc.
- Indirect costs are the operating expenses that a company incurs in its daily operations which are not directly attributed to the production process. Examples of indirect costs include office rent, maintenance cost, employee salaries and benefits, general and administrative (G&A) , marketing, and depreciation and amortization (D&A) expenses.
- Gross profit (or gross income) = Sales revenue - Cost of goods sold - Sales returns/allowances
Why is EBIT Important?Operating income is one of the most important financial measures to determine a business' operational efficiency and productivity. It helps a company assess its ability to generate sufficient earnings to sustain its core business in the long run. Thus, companies should always monitor its operating profit and identify the trend over a certain period of time. Operating income is also a frequently used financial metric to evaluate a company's value for a potential buyout transaction. The higher EBIT as time passes by, the higher the effectiveness of the company's core operations.
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